Oct 21, 2023 - Economy

The SEC vs. stealth activists

Illustration of the SEC logo with a hand in front making a "shushing" hand motion.

Illustration: Aïda Amer/Axios

Sophisticated financiers often turn to derivatives when they want to accumulate a large position in a stock without the market getting wind of what they're doing. The Securities and Exchange Commission would love that practice to stop.

Why it matters: Rich investors love being able to operate in stealth mode, and they have a lot of lobbying clout. The final outcome of this fight will reveal a lot about how much power SEC chair Gary Gensler really has.

Driving the news: A key point of contention in the fight between Texas energy utility NRG and activist hedge fund Elliott Associates is the way in which Elliott amassed a 13% stake in NRG by buying derivatives, including total return swaps, that it didn't need to disclose.

  • The SEC wants to ban such shenanigans, in what Gensler calls "another step toward increasing transparency in this previously opaque market." (Although they're derivatives and not securities, securities-based swaps are regulated by the SEC, not the CFTC.)
  • Already, the SEC has cut in half, from 10 days to 5 days, the deadline for activist investors to disclose a stake of more than 5% in a company. So long as there's a derivatives workaround, however, that change will have little real effect.

Between the lines: Gensler points to a series of financial-market fiascos based around these derivatives, including AIG, Archegos, and LTCM, and says it's incumbent upon him to reduce the risk they pose to the markets.

The other side: Elliott makes the case in its 86-page comment letter to the SEC that "activism plays a critical role in the health of the U.S. capital markets" and that, essentially, the derivatives loophole is the last best hope we have that activists will enable price discovery and improved corporate performance.

  • Without it, they say, activists wouldn't be able to build a large enough position without the rest of the market being able to find out what they were doing and front-run their trades.

Our thought bubble: Axios' Michael Flaherty says the sheer weight of the financial industry's lobbying efforts against the proposed rule makes the chances of it passing extremely slim.

  • If that's true, then we'll continue with the current slightly incoherent system, whereby rules enforced in the cash market are easily circumvented in the swaps market.
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